Regulatory Studies

The SEC's "accredited investor" definition bars investors who earn less than $200,000 a year or have a net worth less than $1 million from taking part in private securities offerings. It's a definition even its mother no longer loves: SEC Commissioner Elad Roisman says it "stands between millions of Americans and opportunities for them to invest their wealth in private offerings," while SEC Commissioner Hester Peirce calls it "one of the more offensive concepts lurking in our federal securities laws." Although the definition was intended to offer "investor protection," it has instead "shut out all but the wealthiest from upside gains that private companies have made over the last several decades," according to Roisman.

In light of such negative opinions from inside the SEC, one might have expected a proposed amendment to the rule to be dramatic. Currently, the SEC's rules define an accredited investor as any natural person: (i) whose net worth, individually or with spouse, exceeds $1,000,000 not counting his primary residence or (ii) who had an individual income of more than $200,000 individually (or $300,000 with spouse) for the past two years and expects to receive the same income this year. But, after taking more than a decade to reconsider it, the SEC's proposal merely expands this old definition, adding certain financial services professionals to the ranks of those well-to-do persons already permitted to invest in private offerings. This is the wrong approach.

The right approach is the most simple: eliminate the accredited investor definition altogether. Permit investors to make their own investment decisions. Far from undoing "investor protection," this change would be one that investors—especially less wealthy ones—would have every reason to welcome.

To understand why, let's start with a bit of background. (For a more in-depth background reading, see this policy analysis.)

It’s difficult to outdo the crypto community when it comes to making bold quantitative claims that, stripped out of context, mislead the incautious. But Financial Crimes Enforcement Network (FinCEN) Director Kenneth Blanco recently came close.

In remarks last week to the annual (and, alas, virtual) Consensus conference for crypto professionals and enthusiasts, Blanco declared that, “since 2013, FinCEN has received nearly 70,000 Suspicious Activity Reports (SARs) involving virtual currency exploitation.” That impressive figure was bound to get attention—and it did. The speech is also likely to reinforce the widespread view that cryptocurrency is a hotbed of financial crime. But Blanco omitted to say that, in 2019 alone, financial institutions filed more than 2.3 million SARs regarding all sorts of transactions, and that, according to FinCEN’s own statistics, virtual currency SARs make up just 0.56 percent of all such reports filed since 2014.[1]

Whom to believe—Blanco, or his agency’s numbers? Were FinCEN an obscure or unimportant agency, the answer might not matter very much. But as the U.S. Treasury Department’s illicit finance watchdog, FinCEN is a crucial enforcer of financial regulations—ones which, according to a 2018 survey, community bankers consider the costliest to comply with. Yet, despite FinCEN’s significance, the SAR database (FinCEN’s main resource for law enforcement) is bloated and opaque, and the usefulness of its contents impossible for outsiders to evaluate. Blanco ostensibly believes that crypto is a source of growing mischief. But absent major improvements to FinCEN’s database and reporting, that hunch will remain unverifiable.

To be sure, Blanco’s agency is relatively underresourced despite its leading role in writing and enforcing the Bank Secrecy Act’s many rules. Its 333 employees and $118 million budget look paltry in comparison with another Treasury agency, the Office of the Comptroller of the Currency (3,699 employees and $1.09 billion), and independent financial regulators such as the Consumer Financial Protection Bureau (1,465 and $510 million) and the Securities and Exchange Commission (4,350 and $2.5 billion). Although FinCEN delegates BSA‐​related supervision to the primary regulators of different financial institutions, only it has overall authority for enforcement of the statute.

Perhaps owing to its limited resources, FinCEN has tended to deputize financial institutions to perform the oversight that other regulators undertake directly. For example, BSA regulations require banks and others to collect, verify, and maintain an up‐​to‐​date record of their customers’ personal information, such as their name, address, date of birth, and taxpayer identification number. They must also develop due diligence policies designed to subject risky customers to additional scrutiny. Since May 2018, FinCEN has also required financial firms to collect beneficial ownership information from their corporate accountholders, so that they might include it in their SARs.

Shifting the bulk of the BSA’s burden to the private sector serves to conceal its weight. But the regulations are onerous, whatever view one holds of their impact on financial crime. According to FinCEN’s own conservative estimate, over the next decade financial institutions may spend as much as $1.5 billion just to comply with its May 2018 rule. That figure only reflects direct compliance costs: staff training, longer account opening processes, and so on. The indirect costs of FinCEN’s regulations may, however, be even greater. For instance, their adverse impact on banks’ willingness to take on customers FinCEN might deem risky is substantial. Residents of border states who hold foreign passports, conduct cross‐​border business, and deal in cash are particularly affected. While these residents may fit the BSA’s archetype of a money launderer, most are not criminals. But banks may shun them all because serving them isn’t worth the extra due diligence cost.

Banks’ strong desire to avoid considerable penalties and reputational damage makes them eager to avoid falling foul of BSA regulations. But this precautionary zeal comes at the cost, not only of lost business, but of resources that might be employed much more productively elsewhere. One example of waste is so‐​called “defensive reporting”: among the 2.3 million SARs filed in 2019, more than 11 percent (262,987) bore the tag “Other Other Suspicious Activity,” hinting that the reports were filed only as a precaution.

Such precaution may be warranted in certain cases. Perhaps a few defensive SARs have even helped to bring financial criminals to justice in the past. It’s difficult to know because FinCEN doesn’t make such information publicly available. Still, many experts point out the alarming rate of “false positive” reports, a finding that should concern advocates of greater financial inclusion because SARs are a decisive factor in banks’ decision whether to close customer accounts. And while some of the SARs with imprecise tags like “Other Other” include additional, more specific classifiers, many don’t. Again, one can’t know the exact proportion of each because FinCEN’s public database doesn’t list information on individual reports.

In forums public and private, FinCEN officials often state that criminal financial activity is on the rise, that they need all the information they can get from financial institutions, and that every single report counts. But most of the time, FinCEN’s word is all the supporting evidence outsiders can hope for. That must change. If, as Director Blanco has repeatedly suggested, financial malefactors are warming up to cryptocurrency, FinCEN should be the first to take this trend seriously by listing “virtual currency” (the agency’s preferred term) as a discrete SAR category. FinCEN should also take a leaf out of the CFPB’s book and release regular reports about suspicious activity trends across the financial system, as the Bureau does for consumer finance trends. Despite mounting SARs, FinCEN has published very little in the last 15 years on the growth of new payments instruments. Yet greater provision of information and data may help not only to alert market participants to rising threats, but to clear up the cloud of suspicion that presently hovers over the crypto industry.

If Blanco is serious about demonstrating his agency’s efficiency and value, he must be transparent with policymakers and the public. Any other approach is likely to hobble beneficial financial activity, without deterring those who seek to undermine our security.

Congress is considering passing additional financial aid for state and local governments. I argued against further aid in this Fox News op‐​ed. One reason is that many states have built substantial rainy day funds, which will help them balance their budgets even as tax revenues decline. Federal bailouts would undermine incentives to build such useful funds going forward.

California has built a substantial rainy day or reserve fund over the past five years, as shown in the chart below from this state report. State residents passed a referendum in 2014 to create the fund structure, and so kudos to Californians for approving Proposition 2 by 69–31. The state is in a better place today both because the reserve fund can be tapped during the crisis and because contributions to the fund during the boom helped to reduce program growth.

California political leaders who supported Proposition 2 should also be commended, including former Governor Jerry Brown. Brown scored poorly on Cato’s Report Cards, but I did note his support of expanding the rainy day fund.

California needs a larger rainy day fund than most states because its revenue system is so volatile. The system is heavily dependent on highly “progressive” income and capital gains taxes, which are tied to growth in Silicon Valley. The top 1 percent of earners pay almost half of California’s income and capital gains taxes, which is remarkably lopsided.

The California Legislative Analyst’s Office (LAO) includes this graphic in its CalFacts publication:

To better handle downturns and promote economic growth going forward, California should restructure its tax system to rely more on sales taxes and less on income and capital gains taxes.

California also needs budget reform because spending rises too quickly during booms. General fund spending rose 6.2 percent in 2018 and 12.1 percent in 2019. The governor has just released projections showing slower 3.3 percent spending growth in 2020 and spending cuts in 2021. The rainy day fund helps, but California government will need to downsize in coming months as revenues fall. Hopefully, the sobering new projections will encourage policymakers to reopen the state economy as quickly as possible.

Over the longer term, California should shrink overall taxing and spending. But its experience shows that even states on the political left can build substantial reserve funds. I argue here and here that when the current crisis passes and the economy starts growing, states should begin building reserves for the next rainy day.

By the way, California’s LAO produces excellent data and studies, perhaps superior to that produced by federal agencies. The CalFacts booklet, for example, has many interesting charts on taxes, budgets, education, and other topics.

Around much of the country retail stores and small businesses are struggling with how to reopen, or carry on operations online, consistent with public health recommendations on social distancing and protection of customers and workers. And as they do they find their task complicated in many ways by the requirements of the Americans With Disabilities Act (ADA) and related state laws. So I conclude from an advice column by Minh Vu and John Egan of the law firm Seyfarth Shaw. Some questions:

* Can you make customers wait outside, and if so how? Under one format commonly approved for reopening, stores must close all but one entrance and have someone watch that entrance to make sure the number of customers does not exceed a given capacity. Once the maximum is reached, customers waiting for admittance need to stand outside in distanced lines. Unfortunately, under the ADA, if only one of multiple entrances is accessible, that one must be used, even if it’s hard to watch, isn’t good for spacing people out, or is exposed to the rain. “Customers with physical disabilities who cannot stand for long periods may ask to go to the front of the line as a reasonable modification. Businesses may be reluctant to allow this as the claimed disability may not be obvious and the request may be fraudulent.”

* Can you take customers’ temperatures before letting them in? Some big U.S. employers already use non‐​contact forehead temperature guns to check arriving employees for fever, and in places like Singapore such methods are also common for customers entering stores. Although the devices have been criticized as unreliable and they don’t catch everyone who’s contagious, they may improve the odds of avoiding in‐​store spread of the novel coronavirus. But the ADA exposes you to legal risk if you use them:

Title III of the ADA does not allow public accommodations to impose or apply eligibility criteria that screen out or tend to screen out an individual with a disability or any class of individuals with disabilities from fully and equally enjoying any goods, services, facilities, privileges, advantages, or accommodations.

You might try to take refuge in one of two exceptions, one that excludes from relevant protection someone who “poses a direct threat to the health or safety of others,” and another that permits “legitimate safety requirements that are necessary for safe operation.” The “direct threat” exception, however, requires “an individualized inquiry into whether a specific person poses a direct threat” and courts have been very stringent with businesses that try to use it. They’ve also been strict with the “necessary for safe operation” defense. Do you think you might get sued on the grounds that forehead guns can’t really be a requirement of safe use if some of your competitors aren’t using them? Yes, you just might.

* What kind of seating will you leave in place? To reflect capacity constraints, many sit‐​down businesses such as restaurants find it best to remove a portion of their tables and seating. Careful about this reshuffling, or it could get legally expensive once you find that you no longer have the required proportion of seating with “a work surface that is between 28” and 34” above the ground, with clear space underneath that is at least 27” high, 17” deep, and 30” wide.”

* How do you move service online? This will be the biggest headache of all for countless small operators who have moved personal services online — tutors, coaches, counselors of all sorts. For more than 20 years now Congress has determinedly refused to clarify when and how online services must provide web accessibility enabling blind, deaf, and fine‐​motor‐​challenged computer users to access all the same services as others. Freelance private lawyers have already sued many thousands of businesses both large and small over alleged web accessibility violations — it takes just one cooperative client to launch a hundred suits or more — and settlements in the thousands or even tens of thousands of dollars are common. Note one problem here with a law that is enforced, by design, by private lawsuits: no official regulator can lift the requirements to reflect the COVID-19 emergency, as is often possible with, say, trucking or occupational‐​licensure rules. Maybe one local ADA lawyer will decide to be reasonable and not sue over a website hastily thrown together in March by a small business trying to keep some revenue coming in during shelter in place. That’s no reason a second lawyer has to hold back.

Administrative agencies don’t materialize from thin air. All agencies exercise regulatory authority only to the extent empowered by an act of Congress or the Constitution itself.

Yet for decades, the Labor Department’s Office of Federal Contract Compliance Programs (OFCCP) has operated a comprehensive enforcement regime, without any basis in the law.

It started in 1965, when President Lyndon Johnson ordered that all government contracts include a set of anti‐​discrimination provisions—collectively, an equal‐​opportunity clause. Since then, the OFCCP leveraged this tenuous foundation into a full‐​blown regulatory scheme, complete with the power to award monetary damages.

In recent years, OFCCP has wielded its power in increasingly aggressive ways. For example, the agency’s onerous and burdensome demands for information often exceed the value of the underlying government contract. Given the absence of statutory constraints—OFCCP is making this up as it goes along—the agency’s evident overreach is perhaps unsurprising.

In the third‐​to‐​last day of the Obama administration, OFCCP filed a bizarre complaint against Oracle, claiming that the company owed $400 million for assorted racial discrimination. The agency lacked a single employee complaint or lawsuit.

Three years later, Oracle is still fighting the charges in OFCCP’s Kafkaeque program. Enough is enough.

Oracle recently sued in a federal district court, arguing that the entire scheme is beyond the law. On Friday, Cato joined an amicus brief submitted in support of Oracle. The brief is also joined by the U.S. Chamber of Commerce and National Federation of Independent Business—it’s rare when big and small business get together on something—and Washington Legal Foundation. We argue that (1) OFCCP’s scheme is far beyond any statutory authority, and (2) striking it down wouldn’t undermine enforcement of anti‐​discrimination laws.

Back in 2018, my colleague Inu Manak and I wrote about efforts to protect dairy producers from their non‐​dairy competitors by keeping the word “milk” off the competitors’ products. The goal is to make it more difficult for soy/​almond/​oat/​etc. milk products to compete with cow milk products, by requiring that non‐​dairy producers call their products “drink” or “beverage” instead of “milk.” Some dairy industry folks in Virginia recently tried this via so‐​called “dairy purity” legislation that would define milk as:

the lacteal secretion, practically free of colostrum, obtained by the complete milking of a healthy hooved mammal, including any member of the order Cetartiodactyla, including a member of the family (i) Bovidae, including cattle, water buffalo, sheep, goats, and yaks; (ii) Cervidae, including deer, reindeer, and moose; and (iii) Equidae, including horses and donkeys.

Thus, if you can get your hands on some moose milk, you can call it milk. But soy/​almond/​oat/​etc. milk producers would have to find another term.

Of course, as Inu and I noted, there are actual definitions of milk already, which are much broader, and include the following: “Any of various potable liquids resembling milk, such as coconut milk or soymilk.” But the dairy industry wanted to redefine the word in a way that gives it a commercial advantage:

“This was a bill that was brought to us by the dairy industry. We have been losing cattle farms at a very rapid rate in Virginia. You can argue the merits of the competition of what constitutes milk, and whether people drink milk the way we used to when we were kids, but the bottom line is they are trying to preserve their unique brand,” said Sen. Chap Petersen of Fairfax City.

They came close to succeeding, but fortunately, they were defeated at the last minute with an executive veto. Here’s how it played out.

For decades, dairy farmers have been fighting over what is and isn’t milk as plant‐​based beverages have been using the name “milk” in their labeling. In grocery stores the different products can be found on the same shelf, making it difficult to separate what comes from an animal and what comes from plants, critics say.

In an effort to change that, Del. Barry Knight, R‐​Chesapeake, filed House Bill 119 that would define milk as the “lacteal secretion, practically free of colostrums, obtained by the complete milking of a healthy hooved mammal.”

…

Any beverage being labeled as milk that fails to meet the proposed definition would be prohibited.

Showing their support to the agricultural community, Del. Chris Runion, R‐​Bridgewater, became a chief co‐​patron to the legislation and Del. Tony Wilt, R‐​Broadway, also became a sponsor.

…

Runion said in a previous interview with the Daily News‐​Record that he added his name to the bill because of whom he represents in the Valley.

Early on, it seemed that the industry might succeed. The bill passed the Virginia House by 66 to 32 and it passed the Senate by 24 to 16.

Pursuant to Article V, Section 6, of the Constitution of Virginia, I veto House Bill 119, which defines “milk” as the lacteal secretion of a healthy hooved mammal and provides that a food product would be unlawfully misbranded if it fails to meet that definition.

Eliminating the ability to label certain food products with the term “milk” could hinder some businesses’ ability to thrive in Virginia. This bill likely conflicts with both the United States Constitution and the Constitution of Virginia and each’s protection of commercial speech.

Accordingly, I veto this bill.

Yes, the statute would have hurt businesses, and it would have conflicted with speech protections. In addition, it would have misled consumers who are familiar with almond milk and other types of milk and expect to see them labeled as such.

There was some talk of a legislative override of the veto, but this attempt ultimately failed. So for now, Virginia is a safe space for all the milks. Nonetheless, the battle over milk definitions is likely to continue.

(It’s worth noting that the legislation would not have gone into effect until 11 of 14 other states in the Southern region also passed similar legislation six months before, after, or on Oct. 1, 2029. But other states have passed similar legislation, so each step in that direction is a bad one).

I’m quoted in Jack Arnholz’s report for ABC News on some of the problems with a very bad new scheme from Sen. Elizabeth Warren and Rep. Alexandria Ocasio‐​Cortez for an emergency ban on corporate mergers. Excerpt:

“A bill like this would harm the economy in general. It would in particular threaten workers, consumers, investors and those affected by the coronavirus,” Walter Olson, a senior fellow at the Cato Institute, told ABC News.

“In crisis conditions especially, mergers are a way for companies with a relevant strength, such as a strong balance sheet or superior distribution channels, to combine with others that may be weaker yet have vital assets such as promising research, a loyal consumer base, or a superior product line. If mergers are blocked, some weaker, yet valuable companies, will flounder, discontinue research, furlough workers or even enter bankruptcy,” he added.

Despite its prominent sponsors, the proposal is unlikely to pass a Republican‐​controlled Senate and White House. Olson said that the possibility the bill becomes law is unlikely.

“This bill is an exercise in political symbolism, not the way an advanced democratic country should approach antitrust policy. It’s the equivalent of a Trump tweet — it lets off steam, everyone can take sides, and it allows momentary domination of a not especially meaningful conversation until everyone moves on to the next,” Olson said.

Selling out to bigger companies is also a main means by which successful tech startups hit the mainstream and win wide distribution for their products; absent the prospect of being able to exit this way, fewer funders and principals will be interested in going the startup route. [cross‐​posted from Overlawyered]